Wednesday, 4 April 2012

So Far, So Good …

There was a palpable sigh of relief this weekend. We have managed to navigate the first quarter of the year without a globe stopping event occurring. There have been one or two hairy moments, but Greece has managed to secure a second bailout; large tranches of debt have been retired by Spain, Italy, and Greece; and we have managed to avoid hitting any of the speed-bumps that we feared at the start of the year.

Indeed, the prospect now looks, if not exactly rosy, then much better than it did in January. There are glimmers of recovery in the US. True, as yet it is a jobless recovery, as some of the higher levels of activity are soaked into output gap, but without a doubt economic activity is picking up in America. The Chinese property market does not look as volatile as it did at Christmas and the transition from the old guard to the new guard seems to be going reasonably well. Even in Europe things are not looking as bad as previously feared. Whilst still likely to be touched by recession, the expected recession in Europe is not thought to be as bad as previously forecast. In the UK, with inflation coming down, those people with work are finding that their living standards are gradually improving.

We are now moving into a phase where, as the threat of economic catastrophe recedes, we have time to worry about the more usual matters of geo-politics. Top of the list has to be Iran. It would appear that the US has no real appetite for military action against Iran, but is concerned about the prospect of military action undertaken by Israel. Underpinning this is a window of opportunity for military action that is starting to close. Israel is attempting to keep this window open by leasing airbases in Azerbaijan, which could prolong the period of uncertainty. Either way, the prospect of disruption to global energy markets caused by intervention in Iran has propelled the price of oil into the $125 a barrel region. This will have an effect on the world economy later in the year.

Although our focus is dominated by one geo-political hotspot – the Caspian Basin – another - the South China Sea - is quietly starting to come to the boil. The South China Sea is full of little rocky islets, whose ownership is disputed by a number of countries, including China. They occupy key sea lanes in the trade between East Asia and the Middle East, Europe, and Africa; they contain key oil and gas reserves; and they contain a number of important fisheries. China claims sovereignty to all of the South China Sea and is developing the naval capacity to back its claim. The US is pledged to guarantee the claims of a number of key nations – particularly Taiwan and the Philippines. With the change in stance of US security policy towards Asia (read: the containment of China), the stage is set for a number of de-stabilising showdowns in coming years.

What could bring things to a head is a change of government in both China and the US this year. It is by no means certain that the policy of ‘business as usual’ will apply in the second half of the year. However, before that there are two potentially difficult elections scheduled. Sometime in the next quarter the people of Greece will go to the polls. This will be the first opportunity they will have had to voice an opinion over the two bailouts that have been negotiated on their behalf. It is quite possible that a popular vote to reject the policy of austerity (and thus the terms of the two bailouts) will carry the day. If that happens, then a ‘risk on’ moment is likely to be triggered in financial markets.

The second difficult election is the presidential election in France. If Mr Sarkozy loses, as the polls currently suggests, the we all ought to be worried about the impact that a newly appointed Socialist President might have. The policy of soaking the rich, doling out borrowed money to client groups, along with reversing the limited reforms achieved in recent years is bound to spook the bond markets. A run on French banks, as depositors seek a safer haven such as German banks, is the likely and unwelcome crisis that could face the incoming President. If it does, then the global financial markets could face a period of turbulence.

Despite looking good at the moment, we haven’t quite come out of the woods yet. It could be that we are currently in a lull before a renewed storm. Equally, it could be that the worst is behind us and that a slow recovery takes hold this year. It is too early to determine which path we are currently following. All we can do is just watch and wait.